Kaman Corp (KAMN) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the second quarter 2010 Kaman Corporation earnings conference call. At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions). As a reminder, today's conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Eric Remington, Vice President of Investor Relations. Please proceed.

Thank you and good morning, everyone. I would like to welcome you to the Kaman Corporation 2010 second quarter conference call to discuss our earnings results and our outlook for the year. Conducting the call today are Neal Keating, Chairman, President and Chief Executive Officer; and Bill Denninger, Senior Vice President and Chief Financial Officer.

Before we begin this morning please be advised that this call may contain certain forward-looking statements such as projections of revenue, earnings and other financial items, statements on the plans and objectives of the Company or its management, statements of future economic performance and assumptions underlying the statements regarding the Company and its business. The Company's actual results could differ materially from any forward-looking statements made due to several important factors described in the Company's latest filings with the Securities and Exchange Commission.

Our discussion today will include references to certain non-GAAP financial measures. Reconciliations of the non-GAAP measures to the GAAP financial statements have been included in the earnings press release. With that I will turn the call over to Neal Keating. Neal?

Thanks, Eric, and good morning. During the second quarter we faced several hurdles in our Aerospace business, both expected and unexpected. However, given the stronger than anticipated performance of our Industrial Distribution business as well as lower corporate expenses, we were able to report earnings slightly above the anticipated range that we shared with you in mid-June. Also I'm pleased to report that we have resumed production of the Joint Programmable Fuze, which I will discuss in more detail in a few minutes. However, I would like to start with our results at Distribution, which were certainly the highlight of the quarter.

After increasing slightly in the first quarter year-over-year, our sales accelerated substantially in the second quarter and were up 35% compared to the second quarter of 2009. Approximately 17% of this growth was driven by the three acquisitions that we have made in 2010, indicating that both our underlying organic growth and the results from our acquisitions were strong. Despite more mixed economic data as we move through the quarter, our results actually strengthened as the quarter progressed with organic daily sales, which exclude acquisitions, up 15% in April, 15% in May, and 18% in June compared to the prior year, and sales per day increasing sequentially each month during the quarter.

While our MRO business performed well, these results were in large part driven by our OEM customers, which we believe suggests that improvement we have seen is due more to underlying demand than inventory restocking by our customers. Perhaps most importantly, we were able to drive a significant increase in our operating margin at distribution as a result of the increased volumes. Distribution's on operating income was up more than 60% compared to the first quarter, driving our operating margin up 100 basis points sequentially.

We have been very pleased by the results from our three acquisitions, which are all exceeding our expectations. As you might recall, Minarik Corporation was the largest acquisition in Distribution's history and is bringing us several strategic advantages, including allowing us to further expand our geographic footprint, significantly increase our served markets through the addition of new product lines, and improve our overall competitive position.

Results from Minarik thus far have been strong. In fact, July orders 50% higher than the prior year levels, and we already beginning to see sales synergies from our joint marketing efforts. Overall it was a very strong quarter for Distribution for both our existing and newly acquired businesses.

Moving on to Aerospace,we experienced a sales decline of approximately $31 million compared to the prior year. The main driver of this underperformance, as we previously announced, was our JPF program, where we encountered a supplied component failure that occurred during acceptance testing, halting our sales at end of May. In cooperation with our supplier and our customer, the Air Force, we subsequently analyzed, tested and verified the root causes of the failure, and we have developed a plan for the introduction of key product improvements to enhance performance at one edge of the performance envelope. We resumed JPF production this week and will incorporate these changes into the design in the coming months.

The Air Force has been very supportive throughout this process, and our JPF program continues to be their fuse of choice. Field reliability of the fuse has never been in question. In fact, we regularly win performance awards from the Air Force for high field reliability. We will continue to work with the Air Force to make further reliability improvements to the JPF fuse to ensure the safety of the war fighter and provide even more consistent production performance. Also, as a reminder we were awarded Option 7 on the program earlier this year, which is currently valued at $45.5 million and provides us with a backlog into 2012.

The remainder of our shortfall compared to the prior year was largely related to a decline in sales of our Specialty Bearing product lines, which had been anticipated but is still disappointing. While our Specialty Bearing operating profit declined in dollar terms, which impacted our overall operating profit, operating margin on these lines actually increased during the quarter. We were encouraged by improved order activity during the quarter, which bodes well for the second half of the year. In fact, the second quarter was our strongest order quarter since the fourth quarter of 2008. The increase was driven largely by orders from Bell Helicopter for both military and commercial programs and increased order activity for the Boeing 787.

Many of our other Aerospace programs had a solid second quarter. Our Sikorsky BLACK HAWK program generated higher revenue compared to the prior year, including erosion coating work. In fact, duringthe quarter we delivered our 1,000th coated BLACK HAWK blade, which highlights the success of the program. Our revenue from the Egypt SH-2 maintenance and upgrade program was lower due to timing, and we had half a shipset of C-17 revenue pushed out due to the Boeing strike in Long Beach.

During the quarter we received a contract for the unmanned K-MAX worth about $3 million from the Army Aviation and Missile Research Development and Engineering Center. We are still anticipating a down-select for the unmanned K-MAX program for the Marine Corps, and if chosen, will likely see a deployment next year. At this point it appears that we can start generating revenue from the program in 2011.

On the SH-2 we continue to work on opportunities for the sale of these aircraft through marketing efforts with several interested parties. With that I would like to provide some perspectives on our view for the remainder of 2010, and then Bill will provide a few more specifics on our performance and outlook.

Commercial aerospace markets appear to be improving, with both Boeing and Airbus recently announcing new orders at the Farnborough Airshow, which are far ahead of those booked at the Paris Airshow in 2009. Business jet production rates also appear to have bottomed, and with the exception of the near-term disruption on the JPF program, our military business remains stable and consistent. And as we move into 2011, the A-10 will begin to contribute to sales. As a reminder, our A-10 program has grown to over $110 million in expected revenue.

At Distribution we are very encouraged with our results for the second quarter and prospects for the second half of the year. While recent economic data has shown some weakness in terms of the health of the consumer and employment situation, the key indicators for our industry, including industrial production and capacity utilization, continue to indicate that we are in an expansionary mode in the industrial sector of the economy. In summary, while the second quarter presented another period of challenges for our Company, we believe there are a number of factors that position us for much improved results in the second half of 2010. Now, I will turn it over to Bill Denninger to walk you through the financials in more detail. Bill?

Thanks, Neal, and good morning. Second quarter sales were $317.1 million, up 8.1% compared to the second quarter of 2009, as the decline in Aerospace was more than offset by significant growth at Distribution.

Net earnings for the quarter were $6.1 million or $0.23 per diluted share, down from $9.4 million or $0.37 in the prior year. This was modestly above our previously announced range of $0.15 to $0.20 due to higher operating margins at Distribution as well as lower corporate expenses, primarily related to the timing of employee healthcare costs.

On a segment basis for the quarter, Distribution sales were $210.9 million, up 35.2% year-over-year, and the organic business was up 15.6% on a sales per day basis. Sequentially sales were up 17.7%. I should note here that despite the increase in sales over recent quarters, organic sales remain below the 2008 level, indicating further potential upside.

Segment operating income was $7.7 million, up 152% year-over-year, excluding one-time savings related to furloughs in the prior year, and up 60% compared to the first quarter of 2010. As a result, operating margin improved by approximately 170 basis points year-over-year and 100 basis points sequentially to 3.7%.

The drop-through rate on our combined distribution business was about 8.5% compared to the second quarter of 2009. This calculation includes our acquisitions, which were contributing at an operating margin above of our organic business, and includes one-time savings in the prior year. On just our organic business the drop-through rate was 17.3%, excluding the one-time savings in the prior year. Minarik was accretive, and keep in mind that we only owned it for two months of the second quarter.

Moving on to Aerospace, sales in the quarter were $106.2 million, up8.9% compared to the first quarter and down 22.7% compared to the prior year. Our operating income of $12.1 million was down 44% compared to the prior year. These declines were largely due to the absence of the $25 million of JPF sales, as well as lower sales of our higher margin Specialty Bearings product lines.

Our effective tax rate for the second quarter was 34.7%. For the full year we continue to expect our effective rate to be about 35%. Capital expenditures were $4.5 million for the second quarter and $8.1 million for the first half. We continue to expect our CapEx to be in the $20 million to $25 million range for the full year. This is higher than historical levels due primarily to a number of IT investments we are making at Distribution and at Corporate.

We generated more than $22 million in free cash flow during the quarter due to focused management of cash across the organization. We are able to achieve despite the absence of earnings from JPF and from the lower Specialty Bearing product line sales. For the year, we continue to expect free cash flow to be in the range of $20 million to $25 million.

Our leverage remains low with a quarter-end debt to cap ratio of 23.6%, which has increased from year end 2009 due to the incremental debt related to the acquisitions we completed earlier this year. We continue to expect our debt to cap ratio at the end of this year to be in the mid-20s. We have no significant near-term debt maturities and a strong balance sheet.

I would now like to provide some additional detail on our outlook for the remainder of the year. In Distribution, we know that recent economic data has suggested that the recovery is likely to be gradual. However, as Neal mentioned, the important indicators for our business, including industrial production and capacity utilization, continue to provide evidence that the industrial sector of the economy remains in an expansionary mode. We were pleased to see results in our organic business strengthen sequentially throughout the second quarter.

With this trend and the contribution from the acquisitions, we remain confident in our ability to meet the outlook we provided in June for organic sales for the year up 10% to 13% and overall revenues in the range of $800 million to $815 million. We expect full year operating margin to be in the range of 3.0% to 3.3%.

In Aerospace, Neal already discussed the JPF program, and we are certainly pleased to be back in production. In the second half we are planning for $60 million in JPF revenue. Because of the disruptions to the program over the last several quarters we feel it is prudent to build conservatism into the outlook. Accordingly, our outlook allows for another several weeks of disrupted JPF production between now and the end of the year.

As Neal previously mentioned, order intake for our Specialty Bearing product lines has continued to improve, with May reaching the highest level since November of 2008 and June orders on par with May, providing support to the Aerospace outlook that we gave in June. This outlook assumes that our Specialty Bearing revenue will continue to increase sequentially and be below prior year levels yielding a stronger fourth quarter than third quarter.

Moving to our other Aerospace programs, while we had previously anticipated that our BLACK HAWK cockpit deliveries would be done in 2010, Sikorsky now upped their orders, and we expect to deliver 170 cockpits for the year, 30 more than originally anticipated and 15 more than in 2009. Taking all this together, we have increased our outlook for Aerospace sales slightly, mainly due to the higher anticipated BLACK HAWK deliveries, partly offset by the pushout of JPF deliver is. We have slightly lowered the outlook for operating margin to address the change in mix away from Option 6 JPF deliver is. Note that this outlook still implies a substantial improvement in second half results. And I would again like to emphasize that Q4 will be significantly stronger than Q3, due in large part to higher Option 6 JPF shipments in Q4. This Aerospace full year outlook does not have any sales related to the [outstanding] helicopters or the unmanned K-MAX deployment.

We continue to expect to incur corporate, interest and income tax expenses in 2010. We expect our corporate expenses during the second half to be on average in the range of $9 million to $10 million per quarter, including expected due diligence costs related to evaluating potential acquisitions. Interest expense for the full year will be approximately $9.6 million, due primarily to the impact of higher borrowing costs and higher borrowings to fund acquisitions. However, as we disclosed in the 10-Q, in July we received look-back interest payment of $6.6 million, which will be recorded as interest income for the third quarter. Therefore our full year net interest expense will be $3 million.

In summary, while we have encountered some challenges in our Aerospace business this year, we believe that we are well positioned for improved results in the second half, and we are very encouraged by the sales and profit grown we have seen at Distribution. With that, I will turn the call back over to Neal. Neal?

Thanks, Bill. Before questions I want to the take a moment to discuss how we are continuing to invest in areas that will drive growth for Kaman in the future.

First, in Specialty Bearings, we are continuing to make investments in engineering and research and development. These investments take time to mature, but we are beginning to see the benefits. For example, a Tufflex component is currently undergoing qualification testing for an application on the vertical takeoff variant of the Joint Strike Fighter, which presents a significant opportunity for the relatively new Tufflex product line.

We also have nice content on the AgustaWestland 169, which just debuted at Farnborough, and we received orders applications on the Sukhoi Superjet 100. We are also focusing on opportunities for both our Aerostructures and Composites businesses and are encouraged that they could result in new work in the future.

In addition, we are investing in Distribution. We talked earlier about acquisitions, but we are also making significant investments in information technology that will benefit the business for years to come. As you can see, we remain very committed to business development, R&D, and capital investments here at Kaman and have several promising opportunities that we expect will help secure our long-term growth. With that, I will turn it back to Eric. Eric?

Thanks, Neal. Operator, may we have the first question, please.

(Operator Instructions). Your first question from the line of Arnie Ursaner with CJS Securities. Please proceed.

Hi, good morning. I guess my first question relates to your guidance for margin on Industrial Distribution. You ran a 3.7% this quarter. You obviously have an pretty upbeat tone, and it sounds like order trends are very favorable, organic growth, there should be a lot of leverage. Could you explain why the margins for the back half of the year -- other than seasonality in Q4,what other factors would be affecting the margin takes for the year?

Arnie, hi. On the first quarter we did 2.7%; first half, 3.2%. There is the seasonal factor you mentioned. We actual have six fewer business days in the second half than the first half. We also put in a merit increase at Distribution on July 1, and that is a pretty significant cost increase for us. Put it all together, we are looking for results at the high end of the range on the outlook, but we do think it hangs together.

Okay. And my follow-up question or second question, in your -- I'm trying to make sure I'm getting the math right on your expectation for the back half of the year on Aerospace. I think what you said, in addiction to creating $60 million of sales, you indicated you assumed several more weeks of outage or startup or other production inefficiencies that could impact things. Given that you are going to end Option 5 in Q3 -- at the end of Q3, I guess my first question is, when you think about the timing of when you might have these outage -- let me ask it a different way. If you didn't have the outages, how much incremental revenue and margin contribution might we have if you don't have the unexpected outages.

The outages are two to three weeks, somewhere in the time period between now and the end of the year, so it is roughly I believe about a thousand units a week would be the impact.

Okay.

And that would equate to roughly, if it were three weeks, around $10 million in sales.

Okay. And then going back to the comment you made about your cockpits. You have different dollar contents, somewhere between $400,000 and $750,000. If you have an incremental 30 units versus what you thought, that equates to about $15 million of incremental revenue.

Right.

Which is sort of consistent with the change you made in your segment sales.

It is more than sort of consistent, Arnie.

Okay. Is there some other factor that is pulling that?

The two big -- the two issues that drove us to change the sales outlook were the cockpits and JPF.

Yes, I'll jump back if queue. Thanks very much.

Your next question from the line of Matt Duncan with Stephens.

Good morning, guys.

Good morning, Matt.

The first question I've got, going back to KIT, it sounds like you guys saw some nice momentum through the quarter there. Did that continue into July?

July was about flat with June, so we would say consistent. And usually the first month of the quarter is slightly weaker for us so, we were pleased that we maintained the sales levels that we had seen in June.

Okay. And then it sounds like it is the OEM customers that are probably driving that momentum. As you look at the various end customer markets are there any end customer markets that are a little better than others at this point?

Matt, the -- as you said, first of all, the OEM side is really driving the increase. They tailed off more quickly in 2009. We are seeing them tick up more quickly. We were pleased, however, that our OEM sales in the second quarter were actually up on a year-to-year basis. If you remember, in the first quarter -- execution me, MRO being up in the second quarter. If you remember, we actually said in the first quarter that was still down 60 basis point.

The strength is pretty much across the board. In the top ten in industries that we look at, all of them were up with one exception, and that was actually food and beverage, which was down just slightly. Beverage that was down just slightly. So it was really strength all across the board. Mining was very strong for us. Metals particularly was strong for us as well. The ones that we still see are not very -- not picking up gypsum for wallboard, as an example, and also cement. But other than that, very strong broad-based performance across all regions for us, frankly, and just about every industry.

Okay. And then moving on to the JPF program, Bill, how much revenue at this point has shifted out of 2010 and into 2011?

About $10 million.

Okay. And would all of that probably be there in the first quarter then as you kind of finish catching up on those shipments?

Yes.

Okay. And then last thing here, and I will jump back in queue. On the $6.6 million one-time interest benefit on that lookback, is that going to be taxed at your normal tax rate in the quarter, or is that going to mess with the tax rate for the quarter?

It will be the normal effective tax rate.

Okay. Thanks.

Your next question from the line of Steve Levenson with Stifel. Please proceed.

Thanks. Good morning, everybody.

Good morning, Steve.

You talked about Bearings being driven by helicopter and 787. When do you think you might see an impact from increased build rate on other aircraft models?

It is a good question. We've really looked at the incoming order rates very closely, as you would expect, Steve. We see clearly the K-Flex as we talked about for both the military and commercial helicopters, Boeing 787. Obviously we are seeing consistency as well on A380, as their ramp-up rate continues. They are now saying they are going to deliver 20 aircraft this year, so that is a big step up from last year.

Actually, our order rates are up significantly for both business and regional aircraft. Interestingly, we believe that that's because they really burned off inventory in the supply chain last year. So we are not expecting any uptick in business aircraft deliveries probably until late 2011, but we think that we are now getting back to where the steady state demand will be for those. So we are pleased with that. We certainly would like to see the Tufflex drive shaft that we are working on with -- on the Joint Strike Fighter to pass all of its qualification testing and begin to see some uptick there as well.

Great, thank you. On C-17, India just placed an order for six. Do you think there is going to be more international orders? How much further does that stretch production for you guys.

I think that would take us --

It should take us to 213.

-- to 213. Steve, it's difficult to tell, because now I think they are going to be depending primarily on international orders. I know clearly Boeing is trying hard to generate the orders and demonstrate the requirements for that aircraft. I think you look at the floods in Pakistan and the way the C-17 is being a used to get aid into there. It is just continuing to demonstrate the role that that aircraft can play in the international community as well as for the US. So we are planning right now that we've got firm orders that will take us through 2013 and certainly would be glad to see anything else that Boeing is able to bring in. But we also think we are well positioned as that program eventually winds down. We have talked about it many times before, but between the BLACK HAWK and the A10 we know that we will be able to offset that when it inevitably does turn down.

Thanks. And related to the BLACK HAWK, do you think the increase in cockpit builds has anything -- I mean, is it more related to domestic deliveries, or are these cockpits being shipped out for final assembly in Poland?

It is my understanding those will be primarily for US buildout.

Great. Thanks very much.

Okay. Thanks, Steve.

Our next question comes from the line of Jeff Hammond with KeyBanc. Please proceed.

Hey, guys. Just on the -- Bill, you mentioned a couple of times the 4Q being substantially better than 3Q. And I was looking for a little bit more help there. Either how do we break up the $60 million of JPF, or as you are looking at the guidance of $275 million to $285 million roughly of Aerospace revenue in the back half, how might that break out 3Q to 4Q? Trying to understand the split a little better.

I can tell you a couple things. In the third quarter on JPF we expect 50/50 Option 5 and 6, whereas the fourth quarter is all Option 6, which as you know is quite a bit more profitable. In terms of the overall margin for Aerospace versus prior year, we think it going to be down slightly in Q3 and up significantly in Q4.

That's overall Aero revenues?

Margin.

Okay.

Aerospace margin.

Okay. And then just on -- just back on the Option 6, JPF profitability. I mean, does that kind of take you to Aerospace corporate average, or does that run above average or?

No, it is actually a bit above average. It is what we like to say is nicely profitable.

Okay. That's helpful. And then just, in -- as you look at the acquisitions, would those have been additive to the margin, the 3.7% margin in distribution, or still diluting that a bit?

No, slightly additive. They actually were a bit higher than our base business or organic business.

Okay. And then, is there a way to quantify, second half versus first half, how much the comp increase layers in in terms of cost or at least margin degradation?

I don't have that number in front of me.

Okay. We can follow up on that. Okay, and thenjust there were a couple of questions about the military moving pieces. Just as you look out to 2011 and just based on some of the changes around C-17 and F-22 from our government, how are you feeling in general about your military business? Kind of bigger picture 2011 versus 2010?

Actually, we feel pretty good about it, because the key programs that we're on -- C-17, as we said earlier, is going to go through 2013. F-22, we have limited content on, so the downturn of that really doesn't have an impact on us. We continue to feel very good about solid BLACK HAWK production by Sikorsky and our support of is Sikorsky on that. JPF Option 7 takes us through 2011. We talked about A-10 ramping up. So as we look at our military business within Aerospace, we feel good about the platforms that we are on. We certainly like to see a favorable outcome in the deployment of the unmanned K-MAX as well and, of course, sales of the SH-2 to add to that base underlying business.

Okay. And then just last thing, A-10 ramp. Is there a way to kind of quantify what we think the ramp is into 2011?

I think from roughly five shipsets this year up to about 20 next year. I believe that is the case.

And what is the content of shipset again?

Around 450, I think. 475.

Thanks, guys.

Your question comes from the line of Jim Foung with Gabelli & Company. Please proceed.

Good morning. That A-10 is a nice ramp-up for you guys in 2011. But my question is on the unmanned K-MAX. Could you talk more about the $3 million content that you receive -- or contract that you received in the quarter? And then when you are looking to 2011, what is the prospect of getting some production contract on that?

Jim, we are really working, as you know, with multiple services with the unmanned K-MAX. The program that we received the $3 million for is really from the Army, and it is a research program that we have been consistently working with them on now for a number of years. So that is a continuation of that contract for continued development of new capabilities for the unmanned K-MAX. That is separate from what the Marines are calling a rapid deployment, and that is where we have demoed the aircraft back in February of this year and where we expect that there should be a request for quote in the near term.

So there is really two different branches of the military that we are working with, both the Army and the Marines for the unmanned K-MAX. The most recent expectation on the part of the Marines is now that the supplementary bill has been signed and moneys have been approved , to be redirected to a deployment program, that they would go into an RFQ. We would expect that yet this year, and we would expect that if we are successful in that down-select for the procurement, that they would deploy likely in the first half of 2011. Based on that, it would dictate how we would address a production ramp-up. But I would not see a production ramp-up in

Okay. Terrific. And then is there any more follow-on on the Army contract past the $3 million that you won this year?

There may well be, Jim. That is a contract, as I said earlier, that we have continued to get funding at for over -- for a number of years. So we would expect that we would certainly work very hard to have that continue and would expect that in today's environment and the need that is out there that it would continue.

Terrific. Okay. That's all I have. Thanks so much.

Thanks, Jim.

Your next question comes from the line of Edward Marshall with Sidoti & Company. Please proceed.

Good morning. A quick question. You said in your prepared remarks, and I don't know if you quantified, you kind of built I would call is a cushion for the JSF. Kind of an additional shutdown. Did you quantify the amount of dollar value?

Ed, it's roughly three weeks we have baked into the outlook, and that would equate to roughly $10 million of shipments.

$10 million. Okay. Is that the $10 million that we assume that would get pushed out into 2011 that could pull forward?

I think that is fair, yes.

And then on the BLACK HAWK, what does it mean for next year, I don't know if you said in your prepared remarks, but is this pull-forward for next year, or increased demand in general?

I think it is in increased demand in general. The -- Sikorsky has got a set contract with the US government that currently, I believe, takes them through 2012. So we may have movement between years based on demand, but I really don't think that it implies necessarily a lower rate in 2011 than 2010. But we will have to just work with Sikorsky as we go forward on that.

Should we assume 170 shipsets next year? Is that fair?

At this -- I don't know that we are prepared to say at this point, because we need more guidance from Sikorsky. We will see what -- we'll see at the end of when we give our third quarter results, Ed, on what we know at this point in time, but I think it is just a little bit early for us to prognosticate.

That's fair. Okay. Thank you very much.

Thanks, Ed.

Your next question comes from the line of Robert Kirkpatrick with Cardinal Capital. Please proceed.

Good morning.

Good morning, Rob.

A couple for Bill to start with. Pension contribution of $10 million was done the last days of the second quarter or first days of the third quarter?

No, in the first week of the third quarter, Rob.

Okay. And I noticed that on your balance sheet the advances on contracts, which had been hovering around $1 million, suddenly jumped up to almost $10 million. What is behind that?

Those are progress billings related to JPF.

Okay. And then finally for Bill, there was made reference in the press release under the Aerospace segment results to cost adjustments on other programs. Could you give me a little bit more detail on that, please?

It related primarily to a program at KPP. It is a long-standing program. We are supplying fuses to a prime who has -- I mean it is fairly complicated -- there was a reduction in the number of units in the contract, and we had to adjust our cost estimates accordingly, and that is just specifically what we are referring to.

And how much was that?

We haven't disclosed exactly how much it was, Rob, but it was a meaningful number.

Okay. If I could move over to Neal for a minute. Neal, if you could give us a little more detail on the JPF problem and on the solution that you came up with?

Okay, Rob, I think, first of all, it did take us a little bit longer to come to conclusion on that than we had anticipated. But what ended up happening is that we had another failure after some 4,000 successful units had been tested. But the unit that -- the supplied component that failed under that test was the same component that failed earlier in the first quarter and also in the fourth quarter. So between the Air Force and ourselves and the supplier, we determined that it was really appropriate for us to take a step back and engage with a third-party laboratory to really do a deep dive and identify the root cause of the issue that we were experiencing at that edge of the performance envelope.

So we engaged in that. We found out that it was an issue that we were able to design several improvements into the product that we could overcome -- we believe it will enable us to overcome the performance again. It is at one corner condition of the operating range for the fuse, and to be able to identify and verify those root causes and also the improvements is what took us longer than we had originally anticipated.

So we have determined in conjunction again with the supplier and the Air Force that we have an appropriate response going forward. We have been able to go back into production. We will introduce these product reliability improvements over the next several months and quarters to make sure that we continue to improve the reliability of the fuse. But again I would outline that we were meeting the requirements from a fuse system performance requirement, hence why we were getting actually some awards for in-service reliability. But it was clear that at one edge of the operating envelope we were experiencing an issue that was cropping up more regularly than we would want.

And did -- as a result of these problems, was the Precision Products business unprofitable for the Company in either the first quarter or the second quarter?

It was unprofitable in both quarters.

Great. Thank you. Now, a second question for Neal, if I could. Neal, could you help us understand the internal debate, as you look at aerospace acquisitions, between making an acquisition that is more proprietary content and therefore higher multiple to buy but higher margins, and more of a labor-based business, which is what many of your businesses are, which would be obviously lower multiple but lower margin as well? If you could speak to that, please.

Rob, it is an interesting debate that we have. Because clearly if we were able -- and I think it is why we have identified the two areas particularly for acquisitions that would augment our Specialty Bearings product line or our Composites area. And in the way we look at it quite frankly comes down to the economics of each when we do an analysis. We would very much like to be able to expand our Specialty Bearings business, because we believe that the technology and capability that we offer there enables us to make, clearly, very strong margins. It is why we have actually continued to invest in additional engineering resources and capital there.

So we recognize that application engineering resources many times there are the bottleneck. So we have continued to invest there. We would certainly like to be able to identify an acquisition that would enable us to grow that business more quickly than we have. And we would associate a lot of value with that as would the balance of our owners.

In the Composites area, it is interesting, Rob, because there is a different dynamic. Certainly Composites has higher margins than some of the other areas that we are in today -- as you said, more labor based. But it would really be important for us in terms of continuing to build scale in our Aerostructures business, which really enables us to successfully bid on larger packages, whether it is for the A350 Joint Strike Fighter or a new narrow body that either Airbus would go or Boeing will eventually go to design.

We would attach to the ability for us to compete effectively in packages, in particular in the commercial area, Rob, because the timeframe for those aircraft is so low -- or excuse me, so long. F- 22 kind of came and is going to tail off, but 737 has lasted a long time. We expect 787 to last a long time. So commercial would be an area that we would really like to gain some balance in as well.

Great. Thank you so much for those comments.

(Operator Instructions). Your next question is a follow-up from the line of are Arnie Ursaner with BJS Securities. Please proceed.

It is CJS Securities. A couple of quick follow-ups. You mention the $3 million research-development contract on the K-MAX. Do you earn any margin on that contract?

I think it is minimal.

Yes.

They are funding our expenses basically.

Okay. And on Industrial Distribution, your guidance for growth, you are showing accelerating organic growth, and in the back half of the year you had it slowing. And you mentioned you hadn't seen a pickup in MRO. Other than -- is there some -- other than just, again, the seasonality, are you trying to indicate you expect a slowdown, or is it just being conservative?

The outlook does assume a bit of a slowdown sequentially. Obviously we would hope that doesn't occur, but we are trying to be reasonably conservative, Arnie.

Okay. And, Neal, you detailed some of the outlook for what I would call preliminary views for 2011 regarding the military side. You indicated a couple of programs and the impact they could have on all of next year. What I was hoping you might do is take a step back and perhaps preliminarily give us a more 30,000 foot view of 2011. You just mentioned, for example that Precision was unprofitable in Q1 and Q2. To is extent you do pick up JPF business, that should show a dramatic improvement in margin for next year. So if you wouldn't mind, expand on just the military piece, but also talk about your overall business globally about how 2011 is shaping up in your mind?

Arnie, I think I would be more than willing to do that at the end of the third quarter. I think a couple of things that have come up that I would comment on are, number one, the earlier question was how we viewed the military programs. Those are long-term programs, and we have talked consistently about the fact that we feel very good about the kinds of platforms that we are on, and the fact that they haven't been impacted to this point in time by any of the downturn in defense spending that have impacted other high profile programs, like the F-22 or the Future Combat System, et cetera.

So we continue to feel good about that. And I think your commentary about just on a year-to-year basis, would we expect to do better in KPP in all of Aerospace in the first half of the year. I think that is a fair comparison based on the challenges that we have faced so far this year, butI would like to leave it at that at this point.

Well, again, I'm hard pressed to see what, barring an economic disaster, I'm hard pressed to see what factors would hold back good growth in 2011. You'll have a lot more contribution from your highest margin business that has been lagging this year, based on trends; the military programs identifiable and ramping; the margin in Industrial, barring an economic downturn, should be improving. Unless your corporate expenses get kind of crazy, it seems to me we get the full year benefit of certain acquisitions. It just seems to me you are setting up a scenario for very strong improvement in 201. And again, you may not want to be precise about the magnitude, but certainly seems directionally you are heading there.

I can't disagree with anything you said.

See you at our conference.

Okay.

That does conclude today's question-and-answer session. I would like to turn the conference back over to management for closing remarks.

Thank you for joining us on today's conference call. We look forward to speaking to you again when we report third quarter results in November. Bye.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. And have a great day.